Fitch Ratings revises credit ratings for Malaysia

KUCHING: Fitch Ratings has revised Malaysia’s sovereign credit rating outlook from stable to negative on Monday while affirming Malaysia’s long-term foreign and local currency at ‘A-’ and ‘A’, respectively.

RHB Research Institute Sdn Bhd (RHB Research) in a recent research report, noted that there were a few risk factors that have attracted Fitch Rating’s downgrade of the outlook to negative and the rating agency believes these risk factors may, individually or collectively, result in a downgrade of the ratings, most likely by one notch.

If it happens, it could lead to outflow of foreign capital and result in higher borrowing costs for the country.

These risk factors include fiscal slippage relative to the government’s targets and lack of progress on structural budgetary reform; further accumulation of contingent or other off-balance-sheet liabilities.

“Fitch’s assessment that prospects for budgetary reform and fiscal consolidation to address weaknesses in the public finances have worsened since the government’s weak showing in the May 2013 general elections.

“This leaves Malaysia’s public finances more exposed to any future negative shock. Indeed, Fitch believes it will be difficult for the Federal Government to achieve its interim three per cent deficit target for 2015 without additional consolidation measures. Fitch sees risks even to the achievement of the agency’s 3.5 per cent of gross domestic product (GDP) deficit projection,” noted the research house.

It added that the Federal Government’s contingent liabilities are on the rise and its debt guaranteed has risen to 15.2 per cent of GDP by end-2012 from nine per cent at end-2008, as state-owned enterprises (SoEs) participated in a government-led investment programme, according to Fitch.

Data on consolidated indebtedness of SoEs, however, are unavailable, which hinders analysis of the sovereign’s contingent liabilities. Also, Malaysia’s fiscal revenue base is low at 24.7 per cent of GDP, against an ‘A’ range median of 32.8 per cent.

“Fitch has long emphasised two key budgetary vulnerabilities: reliance on petroleum-derived revenues and the high and rising weight of subsidies in expenditure. Fitch estimated that petroleum-derived revenues contributed 33.7 per cent of federal revenues in 2012,” noted the research house.

On a more positive note, RHB Research affirmed that Fitch acknowledges strengths in the composition of Malaysia’s debt and in its funding base, as most of the debt is denominated in local currency (97 per cent at end-2012) and has a smooth maturity profile.

“We believe the lack of progress on structural budgetary reform could be due to the general elections, resulting in the Government delaying its reform.

“The situation was compounded by the UMNO general election that has been set on October 5.

“Indeed, the Government has since put on hold its subsidies rationalisation, after it last cut its fuel subsidies in December 2010. This was made worse by fiscal transfer in 2012 and 2013 to help ease people’s financial burden.

“Although the subsidies are projected to fall, it remains sizeable and accounts for 18 per cent of the revenue in 2013, which is still uncomfortably high,” it opined.

Way back in the early 2000s, the research firm noted, the subsidies only accounted for 2.9 to 7.8 per cent of revenue in 2000 to 2004, compared with an average of 18 per cent a year in 2008 to 2012.

“We expect the Government to resume its fiscal reform once the UMNO election is over. This may help to convince Fitch that the Government is committed to bring down its budget deficit through fiscal reform including rationalisation of subsidies and implementation of the goods & services tax (GST) to broaden the Government’s tax base,” it added

RHB Research further commented, “We share the Fitch’s concern over further accumulation of contingent or off-balance-sheet liabilities given that many of the large projects that are spearheaded by SoEs such as the Sungai Buluh-Kajang MRT, the Tun Razak Exchange, Bandar Malaysia and Malaysia-Singapore High Speed train that still need the Government’s guarantee to fund these projects to make it feasible. As it stands, the amount of loans and bonds guaranteed by the Government has risen significantly from RM55.7 billion in 2005 to RM143.1 billion in 2012.”

Another factor that was brought to light was the further erosion of the current account surplus, particularly a ‘twin deficit’ situation where failure to consolidate the budget is associated with the emergence of a sustained current account deficit.

RHB Research highlighted that Malaysia’s external finances remain its key sovereign credit and rating strength, according to Fitch. The economy recorded a net external creditor position worth 30 per cent of GDP at end-2012 against the ‘A’ range median creditor position of 17 per cent.

Additionally, the research firm said the sovereign’s own net foreign asset position of 21.3 per cent of GDP and net foreign exchange creditor position of 44 per cent were stronger than ‘A’ medians of 16.8 per cent and 14.4 per cent respectively. This is despite a decline in the current account surplus to a projected three per cent of GDP in 2013 from double digits each year from 2003 to 2011 amid rising investment and a drop in the savings rate, led by the public sector.

“We highlighted in our earlier note ‘Shrinking current account surplus in the balance of payments a concern?’ published on July 25 that Malaysia experienced a shrinking trade surplus in recent months that will lead to a smaller surplus in the current account of the balance of payments.

“Still, we do not expect the trade account to fall into a deficit in the near term that could weigh on the current account surplus and turn it into a deficit, unless there is a sharp drop in commodity prices, particularly palm oil, crude oil and liquefy natural gas (LNG) prices, from the current levels.

“Nevertheless, we have lowered our trade surplus forecast for 2013 and slashed our projection for current account surplus in the balance of payments to RM20.5 billion or 2.1 per cent of gross national income (GNI) in 2013, from a surplus of RM47.6 billion or 4.8 per cent projected previously and compared with a surplus of RM57.3 billion or 6.3 per cent of GNI recorded in 2012,” it explained.

RHB Research further pointed out that a shock to interest rates or to employment sufficient to impair household debt servicing ability and put pressure on the banking system was also a factor that was brought forth.

Fitch believes Malaysia’s high level of private sector leverage is a risk from a credit perspective, as credit to the private sector reached 118 per cent of GDP at end-2012, above the ‘A’ median 94 per cent. — Reuters

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